focus on: onshore energy construction - marsh
Post on 23-Dec-2021
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THOUGHT LEADERSHIP
Focus on: Onshore Energy Construction
From well pad to plastics with many deviations into civil engineering, power production and many other sub-classes in between, onshore construction is a well-established and specialist insurance market. In this article, we look at the recent market changes and what we may expect in the near future.
The Easy Bit Once the oil or gas is out of the ground, significant
infrastructure is required to treat, transport, process, refine
and store either crude, interim or final products. That is
where the onshore construction market operates. The roads,
pipelines, power, water, accommodation for workers, even
the jetty required for export or imports, the list goes on. It is
often thought it is far simpler to build something you can see
as opposed to drilling thousands of feet below the ground
looking for oil or gas, or battling with hydrocarbons in a Force
8 gale right? Indeed it should be.
But of course, as with all things, we have need for progress.
That arrives in the shape of building things faster and cheaper
and the benefits of that are not just for respective company
CEO’s and shareholders, but to all of us in our daily lives.
Better, cheaper products available to all. Progress is just
one factor that changes risk. Along with economic, political,
geographic and meteorological issues – every company’s
risk profile has changed over the last 20 years; the onshore
construction market, and the insurance industry, may have
miscalculated the risks.
Long-term Nature The onshore construction market has been in a softening
phase since circa 2006. After the tragic events of September
11, insurers saw rate rises, a narrowing of cover and general
stability for four or five years. Thereafter, as buyers of
insurance, we have seen 13 or 14 years of improving insurance
terms and conditions. This article is not about which capacity
has redacted its appetite for the onshore construction sector
- we know significant capacity has left – but it is about the
reasons for its departure and what might occur next.
The complex hydrocarbon projects we typically deal with
take time; three to four years and longer is not uncommon.
Insurance terms and conditions are set at the outset for the
project term, to comply with buyer requirements, lender
requirements, contractor requirements and more. Broadly
speaking, insurance terms do not change much throughout
the duration of a project, though insurers may have some
reasonable flexibility to re-underwrite where a policy change is
requested. Insurers have been shown their previous errors in
the form of unprofitable books of business, they are now faced
with a likelihood that they still have three or four years of their
incorrect past rating to come to fruition. They are all mindful
they have to act now. They are all well aware that the promises of
change they make to their management, and reinsurers today,
will be broken by the tail of the existing projects. In two or three
years the insurers, internal conversations between manager and
underwriter are likely to go:
Manager: You said two years ago the market was changing, it
would all be better in the future…..and still the losses arrive, and still
we lose money.
Underwriter: Yes, but it takes time because of the tail, I promise
what we have been doing will yield better results in the future.
You can permutate the next sentence from the manager as you
see fit. But, for those who doubt this as a likely conversation, we
have seen it all before, circa 2004, well in to the stable market
period, and before the underwriting changes enacted two years
prior started to alter onshore construction results. We apologise
that this is not what we wish to hear – whether we are a client, a
broker or an insurer – but being prepared and advised correctly
can help you through this.
I told you so…So what, and where, did underwriters get things wrong? A few
of the headline issues underwriters have discovered to their
detriment:
1. The insufficient construction premiums of the many were not
enough to pay the large losses of the few. That’s an easy one,
but of course the frequency of small losses also increased.
There was always the fear in the latter stages of the softening
market that there was nothing in reserve to pay for the
overdue, expected big loss that would one day arrive. That day
arrived, more than once.
2. Operating costs are too high, investment income too low,
reinsurance costs have increased – insurers themselves are
inefficient and need to reconsider their models.
3. Modularisation as a risk improvement – Once considered
an improvement in risk control by onshore construction
underwriters, and rewarded with premium discounts, modular
fabrication was seen as a way of performing significant
elements of a construction project in a clean, well-spaced and
controlled environment. Construction could be started earlier
removing on-site bottlenecks and time pressures. All seen
as better than the risk factors experienced on the actual site
where space/people/environmental logistics can add to the
complexity and likelihood of a loss. Undiscovered, an error
in a fabrication yard may be replicated many hundreds or
thousands of times. When the loss is discovered, often on site,
the repair costs may be exponentially expensive as local wage
and/or access conditions may result in significantly higher
costs than the original build.
4. Corrosion – Long seen as a problem, whether due to stress
corrosion cracking or simple rust or oxidation, corrosion
claims had become prevalent and expensive. Tighter
exclusions are being sought by the market and a focus on
paint and coatings is also high on the agenda.
5. Natural Catastrophe (CAT) – construction typically escapes
large losses from high profile CAT events. When hurricanes hit
or floods arrive, risk management plans perform adequately
– and on the occasions they don’t, the values exposed are
generally low. This no longer seems to be the case. In addition,
rising annual costs for CAT reinsurance cannot be passed onto
the client (since the premium terms are set for the duration of
the project).
6. Defects – Claims for defects and poor workmanship
contribute significantly to the insurers’ loss ratios, and they
are consistent, expensive and not going away from the
construction sector any time soon.
Newton’s third law of motion – the one about equal and opposite reactions Elements of the changes may be labelled outrageous, and unfair,
but if the market does not adapt, it will not survive creating a
bigger problem. New capacity will come in right? Eventually yes.
But, while the returns on insurers, capital are good in short tail
markets, a loss making longer tail market looks less attractive –
so onshore construction is forced to adjust prices, and reduce
cover and policy limits. The requirement is for construction
insurers to demonstrate a continued improvement in their
portfolio performance, and risk selection. The question is for
how long, and how much improvement is required?
There has been a lot emanating from onshore construction
insurers which causes concern, including:
• COVID-19 exclusions.
• Cyber exclusions.
• Price rises.
• Deductible increases.
• Curtailed sub-limits.
• New corrosion exclusions.
• Reluctance to offer LEG3 coverage (in accordance with
London Engineering Group definition).
2 • Focus on: Onshore Energy Construction
• Reluctance to offer delay in start-up (DSU) or advanced loss of
profits (ALOP) cover.
• Refusal of, or resistance to, period extensions.
• Fewer insurers willing to offer lead terms.
But these issues can be managed so that a project remains
bankable, and can proceed with adequate risk transfer in place.
Relationships do count, as does a sensible and fair approach to a
request for cover.
So what do companies need to do to smooth the process and
gain coverage?
• The smart buyer today will identify what is most important
to them – Is it cost certainty over the entire duration of the
project, is it low deductibles, is it the broadest cover or a
particular extension of cover you just cannot do without?
Prioritise those needs. Then list the wants. You may not get
all of the desired, but with a good strategy and the right risk
controls in place, you can achieve the ‘must haves’.
• Plan properly – Approach the market in good time and at
good times. A quotation offered the week after a hurricane
or big market loss is not going to be viewed in the best light.
Sometimes it cannot be avoided of course, but if insurers
already had the project in mind before hand, or if you still have
many months to go until likely final investment decision or
notice to proceed, there is time for the ‘unequal reaction’ to
subdue. You need to make time your ally, not your enemy.
• Take a sensible approach to the hurdles – Using an example
– you need LEG3 cover. Insurers may try not to offer it. So if it
is a priority, the carrot needs to be fatter and the stick shorter
if you wish to grab insurers, attention. Maybe full value limits
will not exist for LEG3 coverage (we estimate currently there
may be circa. USD 750 million of useable probable maximum
loss (PML) capacity available for onshore energy projects
with LEG3 – as opposed to circa USD2 billion of useable
PML capacity with LEG2). Work out what you actually need,
the deductible you can really bear and what the contractor,
manufacturer or supplier can accept as a contractual
obligation either by guarantee or warranty. Be mindful that to
tempt insurers to come to the table, the premium loading over
LEG2 has increased.
So what is a buyer of onshore construction insurance likely to experience?
• Price increases –Whether as increased original premium, or
a more significant percentage of pro-rata on extensions, on
average prices are increasing and the trend is unlikely to slow
until insurer profitability improves.
• Quotes open for only short periods –Consider the timing of
the works packages and whether ‘early work’ can be used to
bind insurers to a price for the full works package. Are you able
to purchase a ‘futures option’, giving you the right to purchase
an insurance programme at a specific set of terms within a set
period of time?
• Automatic extension provisions –Insurers accept that
a project may be delayed; however, when an extension is
needed (or when a significant change in risk has occurred)
insurers have the ability to adjust policy terms and conditions
to reflect current market conditions. If whole term certainty
of price is a driving factor for you, insurers will consider that,
but it is akin to them offering a lump sum turnkey approach, so
you can be expected to be charged for that margin.
• Lower sub-limits and higher deductibles – Work with your
broker and risk engineers to fully evaluate your requirements.
Insurers will curtail offered capacity if their exposure is too
great on just one aspect of cover. Think about restructuring
your programme and/or reviewing the value of sub-limits.
• Focus on new technologies or processes – Continue to
ensure you provide comprehensive details, data, and the
validation of any new or scaled up processes to demonstrate
to insurers you have fully considered all the issues that could
arise.
• Longer response times – We have mentioned already
that time can be your ally or enemy. Those insurers left
trading are now seeing more business and cannot always
cope with the volume, especially as additional peer reviews
and referrals are included in the process. A period of
up to six months should be considered as prudent, and
allows for insurer presentations and roadshows. Less is
of course achievable, but make time your ally. See the
below comments regarding period extensions and bear in
mind that operational insurers may have similar issues, so
approaches to transfer construction projects to operating
programmes will also take longer.
• Replacement of existing panel of insurers – For projects
placed some years ago, it is possible that an insurer used then
is now in run-off, or their security has been downgraded. Run-
off does not necessarily mean bad, but run-off markets will
not be looking to extend policies, even if obligated to do so. If
replacement of an existing carrier is required, allow sufficient
time, and provide the relevant information for a new insurer to
fully consider offering terms.
• CAT –We plot values exposed during each season, and use
that to guide the pricing and exposure to insurers. Under
current market conditions, it may be worth considering
smaller limits in the policy in the early years, and stepping
them over time as values increase. Another option to consider
is purchasing CAT annually rather than for term of the project,
though consideration should be given to the risk of price
Marsh • 3
volatility this may introduce. Parametric programmes may
also be available and, depending on whether or not there are
additional assets in the vicinity, the pricing may be applied
across construction and operational assets.
• Exclusions –Engage your project team with your broker
and risk engineers to consider the impact of exclusions,
including cyber, COVID, corrosion, paint and coatings, as well
as challenges to LEG3. Work with insurers, own engineers.
Good insurers would prefer to work with you, and to get
fully comfortable with the measures you are taking to fully
understand risk, as opposed to applying blanket exclusions.
• Further capacity reductions –This may just mean existing
insurers look to offer lower capacity per risk than previously, or
there may be further withdrawals of insurers from the market.
Consider your strategy when placing project coverage.
Be prepared, allow sufficient time, and seek advice from experts
and you will be best placed to navigate the challenges of a
changing market landscape.
TIPS FOR DE ALING WITH POLICY E X TENSIONS:
Fundamental to negotiating the best outcome on any
contract change are time and information. The time required
to negotiate any contract change has dramatically increased
over recent months, meaning early engagement with
insurers is essential. Being prepared with a comprehensive
explanation of the project status is the best way to approach
underwriters - gaps in information often result in higher
premium levels.
Bear in mind that onshore construction insurers may
not wish to extend the construction policy, and onshore
operational insurers may not be able to accept an incomplete
plant in to an operational policy.
Your Marsh JLT Specialty team will engage you early in the
lead-up to the expiry of your policy, and will look to provide
both construction and operational insurers with detailed,
current project information.
While each client, and project, is unique, we have
summarised below the information generally required for
a construction period extension:
Key reasons for the delay:
• Effects of COVID-19 shutdown or delay.
• Changes in the original scope of work or material change
in risk (variation orders, etc.).
• Current status of the project/works currently completed.
• Detailed description and value of remaining works, have
any testing periods been exhausted?
• Detailed timeline and Gantt bar chart for the
remaining works.
• A realistic anticipated project completion date. Avoid
extending the policy for very short periods at a time if,
in reality, the project will not be completed; DSU can
complicate this.
• Confirmation of no known or reported losses, or up to
date details and status of known losses/incidents.
• Details of any proportion of the project which may have
been handed over or put into commercial operation.
• Confirmation of policy sums insured/contract value to
ensure that they are still current.
• Copy of the latest progress report or, if available, a copy of
the latest risk management report undertaken by the lead
insurer or Marsh JLT Specialty Risk Engineer.
• Status of loss prevention recommendations highlighted in
previous risk engineering reports. If not implemented yet,
an update on the proposed plan.
If DSU/ALOP cover is purchased, has a physical damage
claim caused or contributed to the delay? If so:
A. You should be aware that by extending the policy you
may be removing the opportunity to make a DSU claim
until the newly declared completion date(s) is reached.
Indemnity will start from the newly declared completion
date(s)!
B. If you have a situation where one or more claims could
have contributed to the delay, then discuss in good time
with your broker – if it is ‘late in the day’,
it’s more challenging to resolve. Does the DSU section
require reinstatement?
C. Consider carefully the information you need to provide if
you have multiple completion dates.
4 • Focus on: Onshore Energy Construction
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Marsh • 5
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Copyright © 2020 All rights reserved. 20-591959938
For more information and any queries concerning the content of this document, please contact:
DARREN MARSHALLHead of EAR Construction, Infrastructure & Surety Practice+44 20 7528 4202 | +44 7775 733795 Darren.marshall@marsh.com
JAMES COOKSenior Vice President, North America and Global Downstream Energy Construction Development LeaderConstruction, Infrastructure & Surety Practice, UK & Ireland+44 (0) 7979 754 686 James.X.Cook@marsh.com
MARSH JLT SPECIALTYConstruction and Surety PracticeThe St Botolph Building138 HoundsditchLondon EC3A 7AG+44 (0)207 528 4444www.marsh.com
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